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Why Smart Money Loves This Biotech Stock

Smart money tends to prefer larger biotech stocks with healthy cash flow and deep product and drug development pipelines. However, in the end there's only one biotech stock smart money loves most of all.

The biotech sector is something of a roulette wheel for investors. The chances of being right are typically against you, but if you can land a winner every now and then the rewards can multiply many times over your initial bet.

A majority of the biotech sector is comprised of clinical-stage pipelines or developing product portfolios which are still losing money. This means investors have to take a completely different approach to valuing biotech stocks than they do when looking at a consumer products company or a technology company.

For biotech stocks, the most important factor that helps determine their value is the future potential of their pipeline products in terms of both peak annual sales and total patient pool. This valuation method allows for some imagination and emotion to come into play when valuing biotech companies, which can sometimes lead to wild volatility.

Despite this volatility, smart money tends to navigate to the most tried-and-true biotech stocks because they generate healthy and consistent cash flow and also have relatively deep pipelines, meaning the possibility of more growth down the road. When it comes to the largest and most trusted biotech stocks there aren't too many truly superior names to choose from. In the end there are really just four:

Don't get me wrong, there are plenty of other mid- and large-cap biotech stocks for smart money to follow, but these are the veritable "four horsemen" of biotech. But, only one is the stock smart money really loves.

But, one potentially fatal flaw for Gilead is that its HCV therapies could become obsolete if a shorter treatment regimen is developed.

Biogen has also had some similar success lately, with its multiple sclerosis (MS) therapies dominating the market. MS relapse-remitting drug Tecfidera delivered $2.9 billion in sales in 2014, making it one of the most successful drugs post-launch in history (it was approved in March 2013). Furthermore, recent early stage results from aducanumab (also known as BIIB037) for Alzheimer's disease demonstrate it could be the blockbuster Alzheimer's patients have been waiting for. The drug successfully removed amyloid plaques from the brains of patients and delivered an improvement in cognitive function as measured by two tests.

Yet, the drawback with Biogen is that Alzheimer's is a high-risk, high-reward bet. We've witnessed therapies that have shown promise in early and mid-stage trials only to falter in late-stage studies. Betting on Biogen could be a bit of a gamble here following its huge run higher.

Source: Amgen, Flickr.

Even a bet on Amgen could be considered a risk. On one hand, Amgen plans to deliver late-stage results on 10 experimental drugs between 2014 and 2016. We've already witnessed some of the fruits of these studies, with Amgen earning a Dec. 2014 approval from the Food and Drug Administration for Blincyto to treat a rare form of acute lymphoblastic leukemia.

The downside of Amgen's late-stage clinical blitzkrieg is that phase 3 trials and drug launches cost a lot of money. While ramping up these new drug approvals it's possible Amgen could see a few quarters, or years, of pressured margins.

Ultimately, the biotech stock smart money loves -- and the one that has the highest buy rating among biotech's "four horsemen" -- is Celgene.

First, Celgene is growing almost entirely by organic means. Celgene's recently introduced 2020 guidance calls for in excess of $20 billion in revenue and adjusted EPS which is expected to exceed $12.50. To add context to these figures, Celgene's 2014 full-year revenue was $7.67 billion, while its adjusted EPS was $3.71. The implication here is that Celgene will be able to organically grow its sales by at least 161% and its EPS by 237% over the next six years. That type of growth makes it easy for Wall Street to get behind Celgene.

Secondly, Celgene takes a lot of the guesswork out of clinical trials because its primary source of growth is label expansion of already approved medicines. To be perfectly clear, Celgene does have novel molecular entities being developed in its pipeline. But, its primary means of growth is to lean heavily on its blockbuster or potential blockbuster therapies such as cancer drugs Revlimid and Abraxane, and anti-inflammatory product Otezla, and looking to expand the indications for these FDA-approved drugs. While label expansion doesn't guarantee the success of these drugs in new indications, safety and manufacturing concerns are very low since the drug is already approved in other indications. As I said, it takes some of the guesswork out of clinical trials and makes Celgene an easy stock to love.

Source: Celgene.

Finally, Celgene isn't afraid to use its substantial cash flow to collaborate with other drug developers to find what could be the next great cancer or anti-inflammatory product. At the moment Celgene has in excess of two dozen collaborations, and while these could result in high milestone payouts, it also could net Celgene healthy growth prospects over the long-term. There's no shame in partnering up, and Celgene's done a great job of seeking out truly unique partners.

With plenty of organic growth, a rich and deep product portfolio and pipeline, and more than two dozen collaborative partners, it's pretty easy to see why smart money loves this biotech stock.

Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

Author

A Fool since 2010, and a graduate from UC San Diego with a B.A. in Economics, Sean specializes in the healthcare sector and investment planning. You'll often find him writing about Obamacare, marijuana, drug and device development, Social Security, taxes, retirement issues and general macroeconomic topics of interest. Follow @TMFUltraLong